07/27/2009

In
my previous post I provided my observations around the 2Q09 performance of our
SaaS portfolio companies. Two of these observations concerned the overall
lengthening of the sales cycles because prospects are starting to take longer
to make up their mind, and need more interactions with the sales teams.
As a result of these trends the cost of sales is increasing and the margins are
decreasing. Furthermore, as organizations feel more comfortable with the
use of SaaS applications, and more complex systems and processes are
implemented using SaaS models, the implementation of these applications is
starting to require more extensive use of services, including professional
services, (which have lower margins than packaged software).

As
investors we are always very focused on the margins (gross and operating)
achieved, and can be achieved, by our portfolio companies. We continue to
be attracted to the SaaS model because of our belief that it can result in
superior margins (80% or higher) due to short sales cycles and quick
implementation cycles.

The
previously mentioned trends show that the margins we are projecting for SaaS
companies will be unattainable. Our initial diagnosis and repair efforts
centered primarily on marketing and sales. We encouraged our companies to
try to improve and better focus their lead generation efforts with the
rationale being that more and better leads will result in shorter sales cycles,
higher-value contracts and, thus, margin improvement. We also encouraged
our companies to make their software highly configurable so that their services
personnel can customize it quickly and, ideally, remotely, so that services
margins can also improve.

As
the complexity of SaaS applications increases, such recommendations are easier
said than done. In many instances prospective customers want to:
test a particular SaaS application using their own data to make sure that it
fits their needs and processes, confirm that its adoption would not be
disruptive to their operations, make certain that they are comfortable with
corporate data being in the cloud, etc. Once they license the software,
customers expect that services personnel will come on site to properly integrate
the cloud-based software with other, mostly on-premise software they already
own, as well as with on-premise databases that feed the SaaS software.

The
key to addressing these customer needs and improve margins lies in the use of
self-service processes and technology. Today a SaaS company considers
that it has a state of the art web site if it can offer canned demonstration of
its software. Vendors of rather simple SaaS software, e.g., contact management
software, may also allow prospects to try the software on their own for a
period of time (typically 30 days) before buying it. However, for more
complex software, e.g., a marketing automation SaaS application, today
prospects have to interact with the vendor’s sales teams to get a demo of the
software, particularly if they require that the demo uses their company’s
data. The business and margins of SaaS vendors will benefit greatly if
they invest in the development of better and more intuitive user interfaces,
data ingestion, integration and management functionality, well-documented and
metadata-driven APIs, and technologies that facilitate, expedite and
“fool-proof” the provisioning and configuration of their applications.
There already exist several successful examples of consumer software, e.g., Intuit’s
tax preparation applications, where users with no technical skills are able to
test-drive, buy, and effectively use a SaaS application. The best thing
we can do as investors is to continue to motivate and guide our SaaS companies
to employ the methods and technologies that will allow them to achieve the
margins that we believe are possible for this software delivery model.

07/13/2009

With
the end of the second quarter we again took the pulse of our portfolio
companies to see how they are progressing in these difficult economic
times. Of particular interest were the SaaS companies because, as I’ve
written in the past, they had demonstrated impressive resilience to the
deteriorating market conditions between 3Q08 and 1Q09 and were even exploiting
the economic environment to make inroads with Global 2000 customers. The
bottom line is that 2Q09 was tougher for all our software companies including
the ones with SaaS solutions. This situation is not unlike what we hear
from public SaaS companies about their performance during 2Q09.

The
backdrop for 2Q09’’s purchasing environment was the state of the IT
budgets. Through our own informal CIO and business unit executive
interactions as well as from analyst reports we determined that during 2Q09
companies of all sizes continued to cut their IT budgets. Fortunately,
very recent data shows that the IT budget-cutting bottomed out during 2Q09 and
budgets are expected to remain stable for the remainder of the year. I
believe that this stability will make corporate executives more comfortable
spending around IT solutions during the 2H09.

But
let’s return to the 2Q09 performance. We measure the performance of our
SaaS portfolio companies using a variety of Key Performance Indicators, e.g.,
MRR. However, for the purpose of sales performance analysis we look at
the following metrics:

Renewal rates, i.e., what
percent of the customers that were supposed to renew during the quarter
actually did so.

Upsells to existing
customers, in the form of expanding the use of an existing solution (for
example, adding seats), buying additional modules of a solution, or buying
a new solution.

Sales to brand new customers.

Contract terms, including
payment terms since they impact cash flow. We monitor whether
the customer accepts the vendor’s contract terms or whether custom
contracts are created. For example, is the customer signing a
one-year or a multi-year contract? Is the customer willing to pay
for the term in one installment, two, or more?

Sales and marketing costs,
and sales cycle. What was the cost/lead? What did it take to
convert a lead to an opportunity and how much did it cost? What did
it take to convert the opportunity into a sale? Did it require
custom demos, lengthy and costly evaluation periods, on-site visits?

Sales forecast
accuracy. Was the sales force able to close the accounts it projected
every month of the quarter? Were the wins as large as had been
anticipated?

Pipeline coverage needed to
achieve the monthly and quarterly targets.

Our
observations were:

Renewal rates were achieved
but more customers waited until the end of the quarter to sign. This
may be because they were waiting for quarterly application usage
statistics so that they can decide if they may be able to renew with fewer
seats (and therefore for a lesser amount), or because they were trying to
delay as much as possible having to pay for the renewal, i.e.., cash
management.

Upsells became a larger piece
of the new quarterly sales than sales to brand new customers. First,
this trend caused sales forecasts to become inaccurate. Second,
prospects remained engaged but dragged out their decisions. Some
delays were just to the end of the quarter (literally the last day of the
quarter, bringing back memories from on-premise enterprise software sales
cycles). Other delays were to later in the year. During the
quarter our companies also saw more involvement from IT organizations
during the sales cycle even if the solution was targeting a business
unit. Some of that involvement may have been expected since,
increasingly, more Global 2000 companies are interested in on-demand software
and IT tends to provide a necessary input to these purchasing decisions.

Along with the lengthening
sales cycles we also saw the need for more interactions between sales team
and prospect, which of course added to the cost of sales.

We heard from several sales
executives that even with strong qualification criteria after what they
encountered during 2Q09 they now feel more comfortable with 4x pipeline
coverage (i.e., the pipeline must contain qualified opportunities that are
valued at 4x the quarterly sales target) compared to the 2.5x coverage
they were using during the 1H08.

Particularly the smaller
customers opted for annual contracts with monthly billing rather than
bi-annual or even quarterly billing, as was the norm before particularly
for the larger vendors. This will make cash management for the
vendors even more challenging. Fewer customers chose multi-year
contracts even after being offered discounts.

While lead generation is
improving as the awareness and interest for on-demand software are
increasing, conversion rates (leads to opportunities, opportunities to
sales) deteriorated during 2Q09.

Our
SaaS companies continue to weather the storm relatively well. Customers
with “pants on fire” problems continue to buy software solutions that can
address them and they appear to opt for on-demand software over on-premise
solutions because of all the benefits SaaS offers. However, during 2Q09
we saw the negative impact of the economy being felt by the SaaS companies in
earnest. We don’t know yet whether the 2H09 offers any reasons for
optimism so we continue to manage each company very conservatively.

I'd
be interested in feedback from SaaS companies on what sales performance they
saw during 1H09 in general and 2Q09 in particular.

07/09/2009

In
the last 24 hours a lot has been written about Google’s announcement to offer a
web-based operating system. While the announcement was short on details,
the commentary and speculation more than made up for it. The majority of
the discussion thus far has been centered on the impact to Microsoft’s OS and
Office businesses. This may be well-justified because of the importance
of these businesses to Microsoft. However, Chrome OS will also a big
impact to SaaS and cloud computing.

Business
users are continuously increasing their use of SaaS and cloud computing.
In addition to the data I receive from our own SaaS portfolio companies and the
SaaS companies we consider investing that is providing evidence of increasing
usage, a recent survey published by CIOZone showed that over the next two
years users are expecting to increase the number (up to 20%+) of workloads they
run on cloud-based platforms. When only new workloads are considered the
number of workloads that users would consider running on cloud-based platforms
increases even further. Business and corporate IT users list security,
response speed, ease of deployment as the top issues that inhibit the even
broader adoption of SaaS applications. Windows at the client side is
responsible in part for these three issues. Google’s announcement states the
Chrome OS is being built from the ground up on a web-centric architecture to
address exactly these three issues. I’m also certain that the experience
Google has gained developing, deploying and supporting its suite of Google Apps
(Gmail, Google Docs, Google Calendar, Google Talk) that are now used by over
1.5 million companies will be reflected in Chrome OS. All this means that
Chrome OS has the potential of providing a superior environment for running
SaaS applications and deploying cloud-based infrastructures. Google
should be advised to invite SaaS application developers into its development
and testing program not only in order to benefit from their experience while
building the operating system but also to ensure that enough such applications
will be available on Chrome OS from the get-go.

Google’s
choice of netbooks as the initial deployment platform for the Chrome OS may
also be a particularly appropriate one. Netbooks are the fastest growing
hardware segment in 2008 (growing by 185%), and will represent 15% of all
computers sold in 2010. Microsoft has not been paying as much attention
to netbooks because of Vista’s issues and
hardware requirements though this may change with Windows 7. But netbooks
are not only popular with consumers. They are becoming increasingly interesting
to corporate IT because when combined with server-side virtualization they
represent a key technology that enables CIOs to further cut IT costs and
improve their control over the user desktops. They achieve this because
a) they are cheaper devices than the full-fledged PCs, and b) once on a
corporate network they can be made to only run the internet- and intranet-based
applications approved by the IT organization. Cheaper desktops implies
that hardware upgrade cycles can be expedited and more money can be freed for
other IT initiatives, such as the purchase of additional applications.
Many netbooks run on Linux today. While Chrome OS will also be based on
Linux, it has the opportunity to be better tailored to netbooks than “raw Linux”
(since it is being architected from the ground up with such devices in mind).
So, Chrome OS will not only provide a more controllable environment but one
that runs SaaS applications faster and more securely. Having less
expensive desktops, exerting better control over these desktops, and knowing
that these desktops are less vulnerable to security problems and run web
applications better will make IT further accelerate the deployment of SaaS
applications.

Within
a day Chrome OS has succeeded in capturing peoples’ imagination about the
computing opportunities it will enable. Let’s hope that it will be
delivered on time and that it will be robust enough for CIOs to feel
comfortable using it effectively in their corporate environments. Then I
expect to see the beginning of an even stronger cycle of SaaS and cloud
computing innovation.